Resources lead the decline across S&P/ASX 200

Disappointing results by resources companies will ensure the market meets its consensus forecast for a 2.5 per cent decline in earnings across the benchmark S&P/ASX 200, with only one-third of corporate profits reported.

There has been a prolonged cycle of downgrades, where aggregate earnings expectations across the market were reduced by nearly 10 per cent between March and August.

Commonwealth Bank of Australia analyst Nizar Torlakovic said most of that decline was driven by resources companies.

“Since the beginning of August, the aggregate earnings expectations have continued to fall for resources stocks, while expectations for industrial stocks have recovered," he said.

One theme of this season has been companies taking a step back and re-evaluating big projects. There was more evidence on Wednesday when BHP Billiton shelved its $20 billion-plus Olympic Dam project in South Australia because of rising capital costs and lower commodity prices.

Australian company earnings have mostly come under pressure from slower growth globally, particularly in Europe and China, and investors have sought to avoid companies with weak balance sheets and too much gearing.

Companies with gearing ratios higher than expected, such as Leighton Holdings, have been sold off. But companies with less gearing have done a lot better, including Bradken, Westfield Group and Primary Health Care.

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Indeed, the healthcare sector has been a standout as investors look for companies with growth prospects. The sector is set to benefit in the years ahead as the medical needs of an ageing population intensify. Good results have also come from CSL and ResMed.

The other sector which has been positive is general insurance. Insurance Australia Group and Suncorp Group have fared well despite the sector suffering large losses in previous years due to a string of natural disasters. Claims appear to be normalising and insurers have increased premiums to claw back costs.

Companies that have been able to work on cost control have achieved better results. Mr Kirkwood said: “Most interesting to me, there have been a lot more misses on sales rather than earnings. This has been a theme in the banking sector.

“They have done all sorts of things to bring down their cost base including reducing head count."

Cyclical stocks have also been in focus this reporting season, despite being punished earlier in the year as investors favoured defensive high-yield stocks such as Telstra.

Cyclicals have had a bit of a bounce, while some more defensive plays have received a mixed response from investors. “Overall, expectations have been pulled back. The fact that stocks have rebounded suggested that the market may have been oversold in cyclicals and overbought in defensives," Alphinity Investment Management principal Johan Carlberg said.

Companies continue to be very conservative with cash flow and have scaled back dividends more than expected. Weakness has been seen in sectors related to residential housing, building materials, property development and consumer spending.

The market has rallied over the past five weeks, largely on the back of comments made by European Central Bank president Mario Draghi, that he would do whatever it took to support growth in the euro zone.

But Mr Kirkwood, who is revising his year-end forecast in the wake of the resignation of the investment bank’s chief equity strategist, Tim Rocks, doubts the rally will be sustained.

“We are still in a period where it is going to be challenging for markets. It is hard to see [the rally] continuing unless we see better than expected policy decisions in the United States, Europe and China."

Mr Carlberg agreed. “It looks like the market could be ready for a bit of a pause. The market overall is at a low valuation.

“But the earnings outlook isn’t great. To get a change in the market, you need rate cuts to happen or the Australian dollar to weaken," Mr Carlberg said.